E6-1

1
E6-1

• Cash. Money held in checking accounts is defined
  as cash, and there are no restrictions on the
  account.
• Cash. Checks are considered cash unless the
  checks cannot be cashed until a later date (i.e.,
  postdated). In this case, the check date has
  passed, so the checks are considered cash.
• Investment. Certificates of deposit contain
  penalties for early withdrawal. Since the
  certificates mature outside the time frame of
  current assets, this source of cash is not
  readily available and should not be classified as
  Cash.

2
E6-1

• Cash. Because banks have the right to demand
  notice prior to a withdrawal from a savings
  account, the cash in savings accounts is
  technically not readily available. However, since
  banks rarely exercise this right, savings
  accounts are considered cash.
• Cash. Petty cash is always considered cash.
• Restricted cash. Because the company does not
  have ready access to these funds, the 50,000
  should not be reported as cash. The portion of
  the 50,000 corresponding to short-term loans
  (i.e., 15,000) should be classified in current
  assets as restricted cash, and the remaining
  35,000 should be classified as a long-term
  investment or as an other asset.
• Cash

3
E6-7

• Bad Debt Expense 3 Allowance for Bad
  Debts 3 Recognized bad debt charge.
• Allow. For Bad Debts 4
  
  Accounts Receivable 4
• Accounts receivable 1 Allowance for
  Bad Debts 1
• Record write-off
• Ending Allowance Balance
  Beginning Allowance Balance Bad Debt
  Charge Write-Offs Recoveries
• Allowance for Bad Debts
• Write off 4 Beg. Bal . 14
• Bad debts 3
• 1
  4
  18
• End. balance 14

4
ID6-6

• Booking bogus sales to faked companies would
  increase sales and increase the gross profit
  percentage of the company. This has double
  impact on the income statement. Since the cost
  of goods sold would not increase for these fake
  sales, the companys gross profit would increase
  by every dollar of fake sales that were booked.
  After booking these fake sales over a few years
  the impact on the balance sheet would be that
  accounts receivable would be overstated. These
  fake sales to fake companies would not be paid by
  anybody so the company would have an inflated
  accounts receivable.

5
ID6-6

• The impact of a receivables writeoff is a debit
  to the allowance for doubtful accounts and a
  credit to accounts receivable. The Company
  probably would not have an allowance account
  large enough to offset the write-off so that the
  Company would have to take a hit to its income
  statement. The Company's stock price will take a
  significant decrease as a result of a large
  write-off. There are two primary reasons why the
  Company's stock will go down. First, the Company
  had been falsely overstating sales and net income
  which are some of the primary numbers that
  investors use to value a stock. The second
  reason is that investors will have lost
  confidence in the integrity of management to
  report actual results in the future. This loss
  of confidence in management will take a very long
  time for investors to overcome and the Company's
  stock will suffer through this time.

6
Question box p. 260

• Receivables may have increased because sales
  grew, collections slowed, or because of
  acquisitions of other companies, or a combination
  of those factors. An investor's interpretation
  of the company's current ratio and cash flow
  statement should include an evaluation of the
  factors underlying the increase to help determine
  whether the receivables are in fact realizable.
  A favorable current ratio does not mean much
  unless the receivables are in fact collectible.
  Cash flow measures should be used together with
  the current ratio. A large difference between
  net income and net cash from operations because
  of an increase in receivables could be a problem,
  but not necessarily. If the increase in
  receivables is commensurate with an increase in
  sales, it may not be.

7
ID 6-11

• a. Home Depots current ratio in 2004 was 1.40
  (13,328/9,554), down from the 2003 level of
  1.48. Home Depots working capital in 2004 was
  3,774, which changed from 2003s working capital
  of 3,882. The accounts that had the biggest
  impact on these numbers were Merchandise
  Inventories, Accounts Payable, and current
  installments of long-term debt. Most other
  accounts were either up or down by a relatively
  small amount.
• b. Cash and cash equivalents. Cash equivalents
  refer to any short-term investments that have an
  original maturity of less than 90 days and that
  carry virtually no credit risk. Examples of
  these would be investments like US Government
  t-bills that are maturing in less than 90 days.

8
ID 6-11

• c. Home Depots accounts receivable are
  relatively small compared to current assets and
  total assets. In 2004 receivables as a
  percentage of current assets was 8.2 and in 2003
  this percentage was 9.0. In 2003 receivables as
  a percentage of total assets was 3.2 and in 2002
  3.6.
• Receivables management is not a critical element
  to Home Depots operations. Receivables are not
  a large asset for Home Depot because of the
  nature of the sales of the company. Most sales
  are paid for in cash or credit cards. The credit
  card sales are immediately factored to banks for
  cash payment. Footnote 1 indicates that the
  companys reserve for accounts receivable was
  not material as of 2/1/2004.

9
ID 6-11

• d. Expanding operations to China will put Home
  Depot in the position of selling goods in Chinese
  currency and ultimately having to convert those
  sales to U.S. dollars. If exchange rates move
  unfavorably against the U.S. dollar, Home Depot
  will face currency losses. To offset this risk
  against the Chinese currency, Home Depot should
  enter into hedging agreements to minimize
  currency risk. As noted in the first footnote,
  the company currently deals with some foreign
  currency risk adding China stores to its
  operations will require the company to hedge its
  currency position to minimize risk for
  shareholders.

10
Question box p. 295

• If Pier 1 Imports had incorrectly counted ending
  inventory at 300 million, the resultant
  overstatement in inventory of 31 million (300
  million inventory versus the actual of 269
  million), would in turn have understated cost of
  goods sold, and overstated gross margin and net
  income by a like amount. 2000 net income would
  have been erroneously reported at 106 million.

11
Question box p. 299

• Inventories valued using the LIFO cost flow
  assumption reflect older costs, compared to FIFO
  which assigns the most recent costs to inventory.
  In a period of rising prices, use of FIFO would
  therefore produce a higher ending inventory than
  through the use of LIFO. So long as Goodyear
  maintains a certain base quantity of inventory,
  it will always be valued at the older, lower
  costs under LIFO. Over a long enough period of
  rising prices, the difference between those older
  costs and the recent costs used under FIFO can
  become quite large. The case would be just the
  opposite in a period of declining prices.

12
Question box p. 300

• Goodyear reported a 300 million lower inventory
  balance under LIFO than it would have been under
  FIFO this difference correspondingly resulted in
  a higher cost of goods sold, and accordingly a
  lower pretax income. At a 30 percent tax rate,
  the 300 million difference would have saved
  Goodyear 90 million in income taxes.

13
E7-8

• FIFO cost flow assumption
• CGS (75 units _at_ 450) (50 units _at_
  500) (5 units _at_ 600)
• 61,750
• Gross Profit Sales - Cost of Goods Sold
• (130 units _at_ 1,000) - 61,750
• 68,250
• Ending Inventory (60 units _at_ 600)
• 36,000

14
E7-8

• Averaging cost flow assumption
• Cost per Unit (75 units _at_ 450) (50 units _at_
  500) (65 units _at_ 600) (75 units
  50 units 65 units)
• 514.47 per unit (rounded)
• CGS (130 units _at_ 514.47)
• 66,881.10
• Gross Profit Sales - Cost of Goods Sold
• (130 units _at_ 1,000) - 66,881.10
• 63,118.90
• Ending Inventory 60 units 514.47
• 30,868.20

15
E7-8

• LIFO cost flow assumption
• Cost of Goods Sold (65 units _at_ 600) (50
  units _at_ 500) (15 units _at_ 450)
• 39,000 25,000 6,750
• 70,750
• Gross Profit Sales - Cost of Goods Sold
• (130 units 1,000) - 70,750
• 59,250
• Ending Inventory (60 units _at_ 450)
• 27,000

16
Question box p. 331

• Unrealized gains (or losses) on
  available-for-sale securities are considered
  permanent accounts and are carried in the
  stockholders equity section of the balance
  sheet.(Comprehensive income) If the investments
  were considered trading securities, these gains
  or losses are considered temporary accounts,
  appear on the income statement, and are reflected
  in retained earnings.

17
Question box p. 332

• An analyst would be interested in the amount of
  comprehensive income because it provides an
  estimate of the overall change in a company's
  wealth during a period from other than
  investments by owners or distributions to them.
  The wide variety of options for disclosure of
  comprehensive income would not be of great
  concern, because the standard for determination
  of the amount of comprehensive income is the same
  for all companies, and the statement of
  comprehensive income must be prominently
  displayed.
• Do E8-1

18
E8-1

• (1) Trading Securities (A) 50,000 Cash
  (-A) 50,000 Invested in IBM.
• (2) Trading Securities (A) 40,000 Cash
  (-A) 40,000 Invested in GM.
• (3) Cash (A) 45,000 Trading Securities
  (-A) 37,500 Realized Price Increase on Sale
  of Trading
  Securities (Ga, SE) 7,500 Sold IBM stock.

19
E8-1

• (4) Cash (A) 750 Dividend
  Receivable 750 Received dividend.
• (5) Trading Securities (A) 8,000 Cash
  (-A) 8,000 Invested in Xerox.
• (6) Cash (A) 7,500 Realized Price
  Decrease on Sale of Trading Securities
  (Lo, -SE) 5,000 Trading Securities
  (-A) 12,500 Sold IBM stock.

20
E8-1

• (7) Cash (A) 11,600 Trading Securities
  (-A) 8,000 Realized Gain on Sale of
  Marketable Securities (Ga, SE) 3,600
  Sold Xerox stock.
• (8) Cash (A) 30,000
  Realized Loss on Sale of Trading Securities
  (Lo, -SE) 10,000 Trading Securities
  (-A) 40,000 Sold GM stock.

21
E8-1

• The transactions that affected the income
  statement for Monroe Auto Supplies are the gains
  and losses Monroe Auto Supplies realized from
  selling marketable securities for amounts
  different from their purchase prices. Monroe Auto
  Supplies realized gains of 7,500 and 3,600,
  respectively, on the first sales of IBM and Xerox
  stock and realized losses of 5,000 and 10,000,
  respectively, on the second sale of IBM stock and
  on GM stock. Thus, the net effect of the
  dividends, gains, and losses on net income was to
  decrease net income by 3,900. The dividends
  received from the General Motors stock were
  recognized as income in the previous period.

22
Question box p. 337

• The total cash in the form of dividends received
  by Exxon Mobil from its affiliates in 1999 would
  be the amount of reported equity income of 3
  billion, plus the dividends in excess of that
  amount of 146 million, for a total of 3.146
  billion.
• Lets do the review problem on page 349

23
ID 8-10

• Home Depot carries a small amount (26 million,
  out of total assets of 34,437 million) of
  investments. The first footnote indicates that
  the investments are designated available-for-sale
  securities.
• Home Depot labels its goodwill Cost in Excess of
  the Fair Value of Net Assets Acquired. Goodwill
  was 833 million and 575 million in 2003 and
  2002, respectively. The growth in good will
  indicates that Home Depot is growing through
  acquisitions. The Statement of Cash Flow, in the
  Investing section, indicates that the company
  used 215 million of cash to acquire other
  businesses during 2003.
• Footnote 9 indicates that the aggregate purchase
  price of 2003 acquisitions by Home Depot was 248
  million, with 231 million being allocated to
  goodwill and the remainder to the fair value of
  the assets purchased.